Contrary To NQ Mobile’s Claim, Treating Cash As Level 2 Asset Is Not Common Chinese Practice

By Shuli Ren

To give the company credit, the management opened the floor to all investors.

The opening remark was “cash is the king” and the Q&A session was peppered with investor questions on why the company classified its entire cash pile to Level 2 instead of Level 1.

Management was largely dismissive of the distinction, saying it was “common in the industry”, identifying other Chinese Internet companies such as PerfectWorld (PWRU), Qihoo (QIHU), and Sina (SINA) as practitioners.

So with the help of Accounting Professor Allen Huang at Hong Kong University of Science And Technology, we did some data digging.

It turns out: Yes, some names do classify some of their cash – called “cash equivalent” to be specific – as Level 2 assets, but they also hold a lot more cash as Level 1 assets that can be deployed for working capital at any time.

Professor Huang breaks down the numbers for us:

For PWRU, as of the end of 2012, they have RMB 799,632,647 of cash and cash equivalents, and only categorized RMB 312,772,838 of them as Level 2 assets. [Barron's: so more than half of its cash is in Level 1.]

For QIHU, as of the end of 2012, they have $ 380,664 thousand of cash and cash equivalents and none of it is categorized as Level 2 assets. [Barron's: so NQ Mobile did not do their homework properly.]

SINA’s data is not very clean, not sure how much of their cash and cash equivalents are in level 1 or 2. Some are in level 1 and some are in level 2. [Barron's: Alibaba recently bought a large chunk of Sina's Weibo. We are not worried about Sina's balance sheet.]

Anyone who went through the 2008 Great Financial Crisis recalls the debates that centered around fair value accounting – or how you value (and write down) banks’ financial assets. Treating 100% of its cash as Level 2 is heavy-handed.

I also made a few phone calls to analysts in China, who unanimously said this treatment was NOT common among Chinese companies. I am happy to hear NQ Mobile out and prove me otherwise.

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There are 19 comments

OCTOBER 25, 2013 12:54 P.M.

responder001 wrote:

I don't care whether holding Lvl-2 cash is common or uncommon.
NQ said that, in China, Lvl-2 cash can be accessed in eight days. So, it's no big deal.

OCTOBER 25, 2013 1:17 P.M.

DWhite wrote:

Again you seem to want to perpetuate the false accusations instead of trying to clear them up. Why don't you contact NQ, as they invited anyone at anytime to inspect their financial statements and even provide snapshots of their accounts. They clearly stated they generate enough cash flow on a daily basis to meet their operational needs. So, if that is the case why do they need to keep more cash on hand at level 1? Some businesses are not able to generate enough cash flow and must keep more on hand to meet needs. Apparently NQ doesn't, so why is the a bad thing as you and the Professor make it out to be.

OCTOBER 25, 2013 1:18 P.M.

Edward LAN wrote:

Would that a bit of irresponsible to issue a damaging report without strong merits. If their classification of cash as cash equivalents as other reputable companies in China did and PW has routinely audited it's financial statement, without, thus far, qualified their opinion. Muddy Water's action can begin to open a can of worm as these security analysts, with little prudence as their should, has been able to use their "independent" position to raid any companies with heavy shorts for the sake of profit with little hard accounting evidence and peer review. It's different to claim that the company has no cash as opposed to the fact that the company, for conservative reason, to classify cash at a more reserve level. It's also different between laying a false claim that the company didn't have any material business while opposite is true. I have been in accounting profession over 40 years, it just mind boggling that firms like Muddy Water were able to get away with load of unethical or even unlawful profits with "scary" tactics and fast short trades purely on speculation basis. If NQ, besides tackling this accusation head on, proved that the company has not "material" misrepresent their financial statements, Muddy Water should not only be subject to tons of lawsuit but also should be censured and even litigated by DOJ as well as PCAOB for their deliberate actions to cause irreparable damages to the company as well as it's stockholders. False accusation for the benefit of shorts is just as bad as falsifying financial statements.

OCTOBER 25, 2013 1:19 P.M.

tradestar2012 wrote:

i think the company said the cash was accessible within a day. Not 8 days.

OCTOBER 25, 2013 1:26 P.M.

Ed Lan wrote:

Muddy Water's accusation thus far proved to be pure speculation. Just the "cash" item, Muddy Water did not do any due diligence as opposed to routinely audited by PW which has not thus far, issued any qualified opinions. Muddy 's claim that NQ does not have any "material business" is so far fetched that other security firms such as Piper has put out their survey to contradict the claim. Muddy Water should not only be subject to tons of lawsuit but also DOJ and PCAOB should look into their illegal profit from shorts with "scary" tactics.

OCTOBER 26, 2013 12:44 P.M.

Taek-Geun Kwon wrote:

responder001:

What you say is true, but what is also true is that NQ's level 2 cash can be accessed within 24 hours, which is significantly better than eight days (obviously, it can be accessed in one day, then it can also be accessed in eight days). The Chinese banking system is meaningfully different than those of the US. In China, certain large banks--such as the various state-owned banks, like the bank in which NQ's onshore entity (headquartered in Beijing) keeps its cash--provide large depositors the ability to liquidate (turn into hard cash) term deposits within a day. Companies such as NQ that generate a high level of free cash flow and operating cash do not usually do this, since the penalty for withdrawal is the earned interest (which is why a company would choose to store cash in a term deposit to begin with), but it is completely untrue that having level 2 cash somehow increases "operational risk" to a "high" level as the Barrons article from Shuli Ren claims. Shuli clearly does not know the Chinese banking system or accounting well.

OCTOBER 26, 2013 8:11 P.M.

US CPA wrote:

I just checked the latest 20-F for SOHU and PerfectWorld:

SOHU: 100% Level 2

PWRU: 99.99% Level 2

Ms. Ren, you should do more work before writing this type of article.

OCTOBER 26, 2013 8:59 P.M.

US CPA wrote:

Just checked cyou, guess what? 100% level 2.

OCTOBER 26, 2013 9:09 P.M.

tradestar2012 wrote:

Mental note. Do not go to Hong Kong University of Science And Technology for an accounting degree.

OCTOBER 27, 2013 12:58 A.M.

Wildcat wrote:

Prior to writing such an article to the public, you should conduct due diligent to consult varoious reliable sources before blasting this type of immatue articles to make people laugh at you...it is very shame and hope you learn a lesson and correct this article to this whole world....it is such a shame article to damage NQ and Chinese image...

OCTOBER 27, 2013 1:13 A.M.

Faithful Servant wrote:

The China Accounting Blog has a better explanation of this. Level 2 is probably the right answer.

Level 2 is the right answer. Level 1 is only for assets with identical quotes - like securities traded on exchanges. Even bank deposits and CDs are level 2, since there are no quotes on those.

OCTOBER 27, 2013 7:57 A.M.

Dinvest wrote:

Shuli,
Given the following Barrons has I would have appreciated if you would have looked into the accounting standard amendments which were brought into effect in May 2011 by FASB (Financial Standard Accounting Board). As I understand, from the comment below taken from the blog of respected Chinese professor , NQ Mobile actually is one of the very few Chinese companies which is following industry best practices based on FASB recommendation on level 2 categorization: Would appreciate your feedback.

———

Thanks Dr.Gillis I am long in NQ and have done some reading on Level 2 assets and I am of the same view as you regarding the correct categorisation of term deposits.

Seems like NQ and only few other Chinese companies are following similar best practices, based on the sample set I have used of 37 companies. Hopefully this should become industry standard in due course as the FASB accounting standards are implemented.

I would also like to highlight the note which NQ has written just below the 2011 Table which you have inserted above, in their Annual report, specifically the last two sentences of the first paragraph :

“aa) Recently issued accounting standards

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This results in common fair value measurement and disclosure requirements in US GAAP and International Financial Reporting Standards. Including which, the amendments clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements, such as the application of the highest and best use and valuation premise concepts being only relevant when measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets or of liabilities. The amendments also change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. This update is to be applied prospectively for public entities during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted.

The Group will adopt this amendment at the beginning of 2012 but expects no significant impact on the consolidated financial statements of the Group.”

Also I have gone through the Annual reports of around 37 US listed Chinese ADR and I found three more corporates following similar approach: SINA, CHANGYOU.COM and PERFECT WORLD. Interestingly all four of them have PriceWater Coopers as their auditor.

Shuli,
Further to that, the perfect worlds numbers are wrong.
I am sorry, what you are doing here is bordering market manipulation.
You have already been quoted on Fox Business interview, due to the articles you have written.
Dinvest

OCTOBER 27, 2013 2:06 P.M.

One Honest CPA wrote:

It is very disturbing that MW's has such a poor understanding of GAAP.

Two of the fraud claims are clearly incorrect GAAP applications. One being that Level 2 cash is a problem -- this type of classification is a requirement and came into play after the 2009 financial crisis.

The other claim that NQ's service provider Yidatong Technology Development Co. Ltd is required to report revenue at Gross, MW claimed PRC Accounting Standards for Enterprises No. 14 Revenues. Upon reading No.14 Article 2 "The collection charged by an enterprise for third parties shall be treated as debts rather than revenues." With NQ being a 3rd party it was an irresponsible acquisation that NQ;s revenue should have been rolled up and reported at Gross rather than Net by Yidaton.

OCTOBER 27, 2013 2:30 P.M.

Dinvest wrote:

Advising you to offer a sincere apology, quoting the shabby work you have done. Apologising to NQ Mobile and the investor community for shaking their confidence.
It's wrong to keep both your articles running with material misrepresentations.

OCTOBER 28, 2013 7:01 A.M.

Have you no shame? wrote:

This has been incredibly bad reporting by Ms. Ren and a display of incompetence by the HKUST professor. We deserve apologies from both.

OCTOBER 30, 2013 1:06 A.M.

Dinvest wrote:

Guess what substantiating evidence Muddy Waters use in their latest allegations: None other than no due deiligence and irresponsible..........misssss Shuli. Still no public apology ! Wow hats off to you lady. You must be sleeping very well in the night.

From muddy waters report " A Hong Kong based accounting professor Barron’s consulted re
futed this statement with respect to PWRD, SINA, SOHU, and QIHU
(which NQ also cited as an example of classifying all cash as Level 2)."

MARCH 24, 2014 12:04 P.M.

Anonymous wrote:

SAC Capital raised its stake in NQ Mobile to 5.1% last week per this 13G filing dated March 18, 2014:

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Emerging markets have been synonymous with growth, but the outlook for individual nations is constantly changing. Countries from Brazil and Russia to Turkey face challenges including infrastructure bottlenecks, credit issues and political shifts. Barrons.com’s Emerging Markets Daily blog analyzes news, data and research out of emerging markets beyond Asia to help readers navigate the investment landscape.

Barron’s veteran Dimitra DeFotis has been blogging about emerging market investing since traveling to India and Turkey. Based in New York, she previously wrote for Barron’s about U.S. equity investing, including cover stories and roundtables on energy themes. Dimitra was among the first digital journalists at the Chicago Tribune and started her career as a police reporter at the Daily Herald in the Chicago suburbs. Dimitra holds degrees from the University of Illinois and Columbia University, where she was a Knight-Bagehot Fellow in the business and journalism schools. She studies multiple languages and photography.